NYAG fraud charges v. Digital Currency Group, Barry Silbert, Gemini & Genesis

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New York’s attorney general has accused Digital Currency Group (DCG), Genesis Global Capital, and Gemini of knowingly perpetrating a $1.1 billion fraud on their’ investors.’

On Thursday, New York Attorney General Letitia James filed charges of fraud against DCG, DCG’s boss Barry Silbert, DCG’s bankrupt digital asset lending subsidiary Genesis, Genesis’s former CEO Soichiro’ Michael’ Moro, and the Gemini digital asset exchange/lending platform owned by twin brothers Cameron and Tyler Winklevoss (who were not personally charged).

I'm suing cryptocurrency companies @Gemini, @GenesisTrading, and @DCGco for defrauding 230,000 investors out of more than $1 billion. 
 
This is yet another example of the harms of an unregulated crypto industry.https://t.co/ysLVm8nujr

— NY AG James (@NewYorkStateAG) October 19, 2023

In a statement announcing the lawsuit, James revealed that she is seeking not only restitution for the 232,000 investors victimized by this fraud—including “at least 29,000 New Yorkers”—but also wants to “permanently stop Gemini, Genesis, DCG, and its executives from engaging in any business related to the purchase and sale of securities and commodities within or from New York.”

Genesis went bankrupt in January following a daisy chain of insolvencies that started when the Three Arrows Capital (3AC) ‘crypto’ hedge fund blew up in June 2022. Genesis had lent billions to 3AC, while Gemini had lent Genesis over a billion belonging to its Gemini Earn customers. The November 2022 collapse of the FTX exchange and its market maker, Alameda Research—which had borrowed heavily from Genesis—only accelerated this incestuous decline.

Like the Bible, we’ll begin with Genesis…

Despite Genesis claiming in February 2022 that it reviewed its borrowers’ “[m]ost recent financial statements with quarterly update cadence,” the NYAG suit reveals that the last audited financial statement Genesis got from 3AC was in July 2020. (This kind of fiscal incuriosity is a common theme of the suit.)

Before 3AC went under, DCG had been using Genesis as an ATM, receiving over $800 million in loans from January to July 2022. When some of these loans started to come due in July, a DCG exec informed Genesis that DCG “literally [did not] have the money right now.” DCG subsequently “forced” Genesis to extend the maturity dates of its loans (that DCG still hasn’t repaid) and also dictated the interest rates.

On July 25, DCG’s treasurer said the company needed to “preserve liquidity to meet our operating cash needs over the next few months,” forcing Genesis’s managing director into an embarrassing admission: “We don’t have much room to push back, so we will do what DCG needs us to do.”

In the frantic Titanic-deck-chair-shuffling that followed 3AC’s collapse, DCG publicly insisted it was “business as usual.” Quietly, DCG issued a $1.1 billion promissory note (with a 10-year maturity, effectively a dodgy IOU) to restore Genesis’s balance sheet.

On June 13, 2022, Silbert told DCG’s board that Genesis’s “unsecured exposure” to 3AC was “uncomfortably big” and thus, “everything needs to be on the table” in terms of financing. But not all options were put on this table.

Silbert claimed some of the collateral 3AC had provided to Genesis was illiquid as it consisted of shares of the Grayscale Bitcoin Trust (NASDAQ: GBTC) issued by DCG subsidiary Grayscale Investments. These GBTC shares supposedly couldn’t be liquidated due to restrictions on the sale of stock by Grayscale’s affiliates.

This was a lie, as Grayscale has always been in a position to liquidate GBTC shares. It just refuses to do so because permitting withdrawals from GBTC would rob DCG of Grayscale’s 2% annual fees, which are based on total assets under management, not the value of GBTC shares. These fees accounted for around 2/3 of DCG’s overall revenue in 2021.

The Silbert-tongued devil

On June 15, 2022, both DCG and Silbert retweeted a statement from the official Genesis account that “the Genesis balance sheet is strong and our business is operating normally.” On June 17, Moro tweeted that Genesis had “thoughtfully mitigated our losses with a large counterparty.” Moro added that client funds weren’t impacted, and Genesis had “shed the risk and moved on.” Genesis accounts retweeted these encouraging words.

In reality, DCG understood there was a “structural hole” in Genesis that Genesis tried to fill by soliciting additional assets from Gemini’s Earn program. Internally, at least one Genesis exec pushed back on DCG’s public assurances, pointing out that these statements were impossible to defend should the truth come to light.

Genesis then halted issuing quarterly reports detailing its cash flow and income. It also kept its finance team from joining calls with clients, allowing the sales team to deflect probing questions with pre-approved talking points about Genesis’s financial condition.

On June 17, Genesis’s ‘Managing Director No. 1′ told Gemini that Genesis “remains solvent” and had “no concerns on business operations.” The following week, Silbert told DCG staff that they “can’t allow people inside or outside [to] question Genesis’ solvency” lest it spark panic and a run on the bank.

On June 18, despite its dire finances, Genesis loaned DCG 18,697 BTC worth around $355 million at the time. On November 10, DCG repaid some of this loan, not with BTC but with shares of GBTC worth around $250 million. Since Grayscale still wasn’t redeeming GBTC shares, this further bound Genesis’s ability to honor its debts.

On June 30, DCG issued its infamous promissory note, signed by both Silbert and Moro, without providing any collateral and making it subordinate to the repayment of a $350 million credit facility to unrelated third parties. On July 6, Moro tweeted that DCG had “assumed certain liabilities of Genesis … to ensure we have the capital to operate.” Silbert reviewed this tweet before Moro posted it.

With 3AC out of the picture, Alameda Research was the borrower for nearly 60% of Genesis’s outstanding loans not owed to DCG or its affiliates. Worse, these Alameda loans were primarily collateralized with FTX’s illiquid in-house token FTT. On August 16, Genesis recalled around $2 billion of its Alameda loans.

From July to November, Genesis sent misleading reports to Gemini multiple times per week, including claims that the promissory note could be reduced to cash within a year. Internally, DCG execs discussed the “asset quality mismatch” and instructed staff not to disclose the note’s 10-year duration to counterparties like Gemini.

When Gemini requested that Genesis provide proper cash flow and income statements for the second quarter of 2022, Genesis “ignored these requests, and Gemini allowed them to do so.” It wasn’t until October 28 that Silbert approved Genesis, informing Gemini of the reality of the promissory note.

On November 16, Genesis announced it was halting withdrawals and was unable to return Earn customer cash to Gemini.

Gemini feels the Earn

Gemini’s Earn program worked by loaning its customers’ digital assets to Earn’s sole “approved borrower,” aka Genesis. In exchange, Earn customers were promised generous rates of return—”among the highest rates on the market,” according to the Earn website—while Gemini collected commissions from Earn customers on both their borrowed assets and their yield. Gemini earned $10 million from these commissions, along with $22 million in agent fees.

As early as March 2021, a Gemini risk management staffer who reported directly to Gemini’s Head of Risk warned that public claims of Genesis’s loan book being “overcollateralized” were misleading. From December 2020 to September 2022, Genesis’s collateral coverage ratio was never higher than 90% and occasionally as low as 60%.

On May 14, 2021, a Gemini internal analysis found that Genesis was “highly leveraged, with over 95% debt to asset ratio.” That same analysis found Genesis had “low liquidity. The business is just able to cover its short-term obligations.” The analysis concluded that Genesis posed a higher risk than other potential Earn partners, but this didn’t alter Gemini’s plans. By May 2021, Gemini customers had given Earn $2 billion. By August, it was $3 billion.

But by February 2022, Gemini’s risk managers were warning there was “a 50-60% default rate for Genesis” in the wake of a market downturn. Gemini internally downgraded Genesis’s credit rating from BBB (investment grade) to CCC (junk status) while continuing to publicly declare that Earn customers could have “trust and confidence” in Gemini and that Earn investments could be “redeem[ed] at any time.”

By May 2022, Cameron Winklevoss was starting to have doubts about Earn’s exposure to Genesis. But instead of warning Earn customers, Gemini’s risk team suggested taking steps to “[r]educe [the] reputational risk [to Gemini] arising from a Genesis default.” These proposed steps included tweaking Earn’s branding and taking measures to “properly set clients’ expectations.”

By July, Gemini’s board was considering whether to “proceed with an orderly shutdown” of Earn. A director unfavorably likened Genesis to financial services firm Lehman Brothers—whose collapse was a major factor in the 2008 global financial crisis—but no concrete decision was taken. From that point until Genesis halted withdrawals, Gemini sent “additional hundreds of millions of dollars’ worth of [Earn] investor assets” to Genesis.

On August 8, Cameron informed Genesis’s ‘Managing Director No. 1’ that Gemini would wind down Earn unless DCG could personally guarantee repayment of Earn customer cash. Gemini never received such a guarantee but continued to offer assurances about its “trusted” third-party borrowers to Earn customers, some of whom invested more in Earn.

On September 2, after finally realizing the danger, Gemini decided internally to scrap Earn. On October 13, Gemini quietly informed Genesis of its decision to wind down Earn and demanded the return of all Earn customers’ cash. On October 20, Silbert told Cameron that Genesis couldn’t return this cash without declaring bankruptcy.

Gemini failed to notify the public of its decision to wind down Earn, nor did it disclose Silbert’s bankruptcy comments. But members of Gemini’s risk team “closed out their personal positions” in Earn. Among the more notable withdrawals was Gemini’s chief operations officer, who withdrew his entire Earn investment, a sum greater than $100,000.

Meanwhile, Gemini “kept soliciting investor assets,” transferring “tens of millions of dollars’ worth” of Earn customer assets to Genesis. Among Earn’s 232,000 customers, the suit notes the impact Gemini’s downfall had on some New York residents, including a septuagenarian couple who lost their entire $199,000 life savings.

Why is everybody always picking on me?

Letitia James said the NYAG launched its suit because investors like that elderly couple collectively “lost more than a billion dollars because they were fed blatant lies that their money would be safe and grow if they invested it in Gemini Earn. Instead, Gemini hid the risks of investing with Genesis, and Genesis lied to the public about its losses.”

Today, the @NewYorkStateAG sued Genesis, its former CEO @michaelmoro, its parent company @DCGco, and DCG’s CEO @BarrySilbert personally for conspiring to lie and defraud Gemini, Earn users, and other Genesis creditors. The NY AG’s lawsuit confirms what we’ve been saying all along…

— GeminiTrustCo (@GeminiTrustCo) October 19, 2023

Gemini’s response to the suit came via a tweet from its official account, offering enthusiastic support for prosecuting DCG, Silbert, and Moro while “wholly disagree[ing]” with Gemini being charged. “Blaming a victim for being defrauded and lied to makes no sense, and we look forward to defending ourselves against this inconsistent position.”

DCG/Silbert issued a joint statement, with DCG saying, “we fully intend to fight the claims and look forward to being vindicated … DCG has always conducted its business lawfully and with integrity.” DCG claimed to have been “blindsided by the filing of this complaint, and there is no evidence of any wrongdoing by DCG, Barry Silbert, or its employees.”

Silbert offered his personal view of being “shocked by the baseless allegations” in the complaint, adding that “honesty and integrity have always been my guiding principles.” (Not since Casablanca has a claim of being ‘shocked’ rang so hollow.)

pic.twitter.com/VBVekMaSDU

— DCG (@DCGco) October 19, 2023

Clearly, the self-pitying outrage machines at both these firms haven’t bothered to actually read the complaint. They also appear to have memory-holed their own words and deeds while this whole farce was ongoing.

Post-bankruptcy restructuring efforts have so far failed to mollify Genesis creditors, including the Winklevii, who’ve launched a noisy PR campaign intended to shift the blame for the lack of due diligence from themselves back onto DCG. But public reports of nine-figure withdrawals by the twins as Genesis was circling the drain aren’t helping their cause.

With the NYAG having acted, expectations are high that the Department of Justice will soon file criminal charges against Silbert and the Winklevii. The fact that this hasn’t happened yet shouldn’t offer any solace to the antagonists. After all, the Celsius Ponzi scheme collapsed a full year before the DoJ unsealed its criminal charges against CEO Alex Mashinsky. So everyone involved in this sorry saga may yet have the Worst Christmas Ever.

Paging Gary Gensler

The NYAG suit claims both Genesis and Gemini “systematically deceived” Earn investors regarding the lawfulness of Genesis’s operations. Months before Earn’s launch, Genesis’s chief legal officer had warned that the program “may be viewed as an investment contract under the securities laws.” But, Genesis took no steps to ensure the program was compliant and continued to represent that it was authorized to transact with Earn customers in New York.

The lawsuit makes plain that “Earn investors’ fortunes were tied to the effort and expertise of Genesis,” and investors “shared in the profits” made by Genesis. In other words, the defendants seem to have ticked the boxes of the Howey test for determining which investments qualify as securities under U.S. law.

In January, the U.S. Securities and Exchange Commission (SEC) filed civil charges against both Gemini and Genesis for the unregistered offering of securities via Earn. The two companies have filed to dismiss the suit based on their claims that they were engaged in a simple loan-making business.

Meanwhile, the NYAG suit has sparked debate as to the future of Grayscale’s years-long (so far futile) effort to convince the SEC to let it convert GBTC to a BTC spot-based exchange-traded fund (ETF). Not everyone is convinced Grayscale’s efforts on this front have been sincere, as this shift would allow GBTC holders to finally redeem their shares for actual BTC.

In August, a federal court ordered the SEC to reconsider its rejection of Grayscale’s ETF application, and the SEC announced this month that it wouldn’t appeal this ruling. Grayscale filed a new application on Thursday, which gives the SEC 45 days (90 days if it chooses to extend the review) to consider this latest application.

Grayscale’s timing could have been better, given its parent company’s awkward moment in the legal spotlight. But BTC bulls are positively giddy at the thought that the SEC may have met its match. More impartial observers—those not holding big BTC bags desperate for upward price movement—believe the SEC will simply issue another rejection. After all, none of the BTC market manipulation concerns that led to the previous rejections have been addressed (and can’t be addressed until Binance and Tether are toast).

We’re sorry that this took almost as long as the Bible to read. We wish we could close with the ‘crypto’ version of the Book of Revelations, with all of God’s stored-up vengeance falling upon the charter members of the Crypto Crime Cartel. Then maybe the rest of us could stop feeling like we’re living the Book of Job.

Follow CoinGeek’s Crypto Crime Cartel series, which delves into the stream of group—from BitMEX to Binance, Bitcoin.com, Blockstream, ShapeShift, Coinbase, Ripple,
Ethereum, FTX and Tether—who have co-opted the digital asset revolution and turned the industry into a minefield for naïve (and even experienced) players in the market.